Chapter 4: Empirical Findings 4.1 Introduction
4.5 Cross-case analysis
4.5.1 Key political risk elements in IPOs
The cross-case empirical analysis reveals that Wärtsilä’s IPOs were mostly affected by 5 of the 11 previously identified political risk elements which are currency inconvertibility, breach of contract, terrorism, taxation restrictions, and import/export restrictions. The table 18 below illustrates that, 4/4 (100%) of the respondents experienced currency inconvertibility as of the major political risk in the selected IPOs. Whereas, breach of contract was experienced in ¾ (75%) of the IPOs. On the other hand, taxation restrictions and terrorism risks were experienced in 2/4 (50%) of the IPOs. Lastly, import/export restrictions and demonstrations, riots & insurrections as political risk elements were experienced in ¼ (25%) IPOs. The following sub-sections provide detailed account of these identified political risk elements in Wärtsilä’s IPOs.
Currency inconvertibility
Currency inconvertibility has been found as a major political risk for Wärtsilä’s IPOs in the selected countries. Since all of the different four countries have different local currencies Wärtsilä’s IPO experience suggest that cautious had to be invested to avoid the risk. Even though none of the selected countries have any strict national policy regarding foreign firm’s ability to repatriate profits from those host-countries but to avoid foreign currency exchange rate changes and risk exposure of currency hedging and so on Wärtsilä uses EURO as a medium of currency while selling EPC projects to these countries. Moreover, progressive payment (often 100% payment are made before on boarding the equipment on vessel from Finland) in Euros assisted Wärtsilä to easily avoid currency inconvertibility risk in Bangladesh, India and Pakistan.
According to the corporate HQ point of view, Wärtsilä avoids currency convertibility risk by adopting a companywide policy of not trading in the local currency of the host-IPO countries. In this instance, it has been consistently found in Bangladesh, China, India and Pakistan cases that Wärtsilä utilizes Euro currency as the medium of business transaction.
Even though in some other host-countries Wärtsilä might be utilizing USD as the medium of payment but euroization of business transactions have found to be most effective for the company. In this instance, in Wärtsilä’s IPO contracts the company specify and stress on the payment medium in Euro currency. However, in support of the view Respondent 4 illustrates,
…“In those emerging markets (Bangladesh, China, India, Pakistan, and other), we avoid doing any contracts in the local currency, especially if there are some currency related risks. I think it sets USD or Euro these are the two preferred ones. And for example, in some of the African countries, there is a high risk that currency has no value or even if there is a value there will be again further degradation. In those cases, we always assess the international review and then the corporate decision is to make contract in either USD or Euro currency.”
According to the Respondent 1, Wärtsilä never do business transaction in Bangladeshi Taka to avoid currency rate fluctuation problem. To illustrate the strategy to avoid this risk in Bangladesh, Respondent 1 reported,
…”Currency inconvertibility can be a problem is Bangladesh and we always do business transaction in Euro currency. That’s why we advise our customers to become the member of foreign currency dealing agency, Bangladesh Investment Development Authority (BIDA) or receive approval from the Bangladesh Bank to deal with foreign currency payment such as paying in Euro for our EPC products.
And, by this way we avoid the currency inconvertibility problem.”
On the other hand, having contract clause specifically address the payment medium in Euro currency is tremendously benefiting Wärtsilä’s Chinese and Indian operations. For instance, Respondent 2 addressed,
…“Currency is an issue in China, but we try to avoid it. That is the reason when we made a contract with another Chinese company, we sold it in Euro currency, and we didn't take the risk of that one. So that kind of risk we passed on to our customer by making euro as the medium of payment currency.”
However, when it’s come about business transactions between Wärtsilä India and Indian customers especially for the spare parts and other life cycle maintenance payments it has been found that Indian rupees are being used. The Respondent 3 commented,
…“Our customers are responsible for payments in Euro currency. So we don’t do business in local Indian rupees. That’s why we don’t have to convert any money into USD or Euro for example. So, when it's any business with Wärtsilä Finland and India then transaction is in euros but Wärtsilä India and customer in India is in Indian rupees.”
Breach of contract
Breach of contract as a political risk element has been consistently found in many IPOs executed by Wärtsilä in the selected case countries. And, the corporate HQ is also perceives this risk element as a considerable threat to execute projects in many countries, including the EMs. Often the company has also be experienced that breach of contractual terms have led to commercial disputes. In this instance, corporate HQ correspondent &
Respondent 4 mentioned,
…“The breach of the contract, I think this is very common in developing as well as in developed countries. But if you talk about the breach of contract on the payments like a bigger payment which then turns into disputes, we have seen quite many so this is not abnormal in projects.”
Moreover, there are various reasons for such breach of contracts which may range from but not limited to sudden bankruptcy of the customers or customers who are unable to receive essential permissions from the host-governments to commission the project in time, etc. But, in any case, Wärtsilä prefers to have certain bank guarantee or LC as a risk management mechanism to avoid such breaches. Drawing on a previous case example, Respondent 4 reported,
…“So, for example, in one case we shipped the equipment and the delivery terms were to be paid by the customer when the equipment reaches the customer’s port. So, when the equipment reached there we delivered the documents to the customers that now these are the documents and according to the contract you have to pay. So, when we were collecting the documents and making the invoices it didn't take more than a day or two to inform the customer with needed information. And, within that time customer informed us that they have went
bankrupt. So, they are unable to pay the money immediately but they didn't say that they will not pay, but they said we cannot pay at the moment. There were certain guarantees in place such as the bank guarantees. So, we knew that the money will come either by the customer or by the banks. So, it took about four months to receive the payment, I think it was around €50 million. The equipment was put on the port and that was a clear breach of the contract.”
Whereas, the Indian case illustrates that breach of contract can also be stemmed from certain rule of game change or policy change in the host-country’s government level. For instance, Respondent 3 reported that a customer In India could not pay Wärtsilä in time because after the project commissioning the end customer could not start the project operation and thus refused to pay the project price as agreed in the contract. The Indian customer’s argument was because they haven’t get the gas supply because of a sudden change in the government’s rule regarding the distribution of gas supply to all of the new customers owing to a nationwide gas supply and distribution crisis. However, the customer company submitted a bank guarantee by which Wärtsilä was able to recover some portion of the project price.
To reveal the reason behind this breach of contract, Respondent 3 argued this risk occurred not because the customer would not have liked to pay the project price. It was mainly because the Indian government has suddenly change its rule of game by providing excuse of nationwide gas supply crisis to all of the new gas customers such as this client of Wärtsilä. Moreover, the customer also did not evaluate the project scope and its capability, local networking and personal relationship with host-government institutions well in advance. Nevertheless, Wärtsilä also failed to choose the right capable local partner and evaluate its scope and capabilities in terms of personal relationship with the local host-government. Respondent 3 further mentioned,
…“Breach of contract happened as they were not in a position to get a gas supply for totally different reasons. The government had a policy change (Rule of game) during the execution stage and said that they were not having enough gas reserves. So, they said that all the new consumers will not be given any gas supply. They (The client company) actually did not do proper evaluation actually, before going for the project. So, they did not get the gas production and gas was not available, they were not in a position to start the operation. So, it was kind
of frustration he was having. So to overcome that frustration, Wärtsilä accepted his bank guarantee.”
On the other hand, a rule of game change or sudden policy change from the host-country’s industrial environment such as from the major utility supplying company can also trigger breach of contract issues. For instance, Respondent 1 reported that in Bangladesh case, because of the local gas Distribution Company’s sudden change in the policy decision regarding industrial pricing Wärtsilä's client company could not get the gas connection to start commissioning and executing the project in commercial operations. Since the client company couldn’t start the project in time it’s somehow also restricting Wärtsilä's ability to close the project, finalize payment in time and move on to the life cycle maintenance contract.
This finding on the breach of contract stemmed from the sudden policy change and rule of game change in the host-countries’ political and economic environment corroborate the previous findings of Butler & Joaquin (1998), Zhang & Wei (2012), Casson & Lopes (2013), and Han et al. (2018).
However, Wärtsilä’s overall approach towards breach of contract is very flexible as the company wants to maintain good long term customer relationships. Respondent 4 concluded,
“So, we focus on long term relationship with the customer. So, sometimes you live with those breaches and if those are of smaller nature, then you absorb those risks relate to the cash flows and then you move forward.”
Taxation restrictions
Taxation restriction risk has been found to be a problem in Chinese and Indian IPO contexts. But, Wärtsilä in both of the host-countries operate as a limited scope project company. In China, Wärtsilä devised its strategy in such a way that clearly specify the scope of Wärtsilä responsibility and customer responsibilities. In all cases, customers are liable for all kinds of host-country related taxation and custom duties, whereas Wärtsilä as EPC exporting company pay for the required customs and duties. In this instance, Respondent 2 outlined,
…“We sell our EPC projects to Chinese customers excluding all the taxes, we say to the customers that they have to pay all the custom duties and everything. So this is their responsibility. So basically, when before making a contract, we will also make a scope of supply kind of a document. So in the scope of supply, we mentioned, who's responsible for what? So the taxes and duties, everything's is part of customer scope. So we will not take that.”
Moreover, involving a capable local third party in Chinese operation has also assisted Wärtsilä to avoid the taxation risk. For instance, the Respondent 2 stressed,
…“Because we sold everything by the third party, so the third party has to take the risk of the taxation. So we don't have any risk of that. We knew that if you sell locally, then this risk will come.”
Whereas, In India there are some differences in national and individual state level taxation policies, which also create some issues. But, Wärtsilä avoids this risk in India by keeping its scope limited only to exporting EPC projects to the local customers. Thus local customers are responsible for their own income and import taxes. Where Wärtsilä pays applicable custom duties, taxes as agreed on the project contract. The Respondent 3 commented,
…“Sometimes, some tax rules are different such as the national rules and the state tax rules. So because of these differences, sometimes we face the problems, but generally the impact is very less. In most of the cases, what we say is that all the taxes have to be borne by customers.”
Terrorism
Terrorism as a political risk has been found evident in Bangladesh and Pakistan IPO cases.
Even though both Bangladesh and Pakistan is relatively politically safe host-countries but certain terrorism risk can still be present in these markets. For instance, because of the internal conflicts among rival groups of a particular host-country, an IPO site can be unexpectedly in the middle of the conflicting areas or be declared as an active warzone or might experience certain terrorism attacks or activities. However, keeping IPO contract in such host-countries for instance in Pakistan where a certain areas have reputation of having rival conflicting groups or terrorist activists as limited scope as possible certainly assist to avoid and manage terrorism and war induced political risks. To vividly light on
the importance of having an arm length/optimal contractual relationships in particularly volatile host-countries, Respondent 4 commented,
…“I think in one country you can have an EPC contract and the same country you can have an arm length for example, in Pakistan, there was a project built by a builder in a region, which was somehow declared as a warzone. So, those areas were quite much affected by the terrorists or terrorist activities. So, in that part definitely we will take care so that maximum risk can be transferred to someone else. So there we will have only arm length contractual relationship.”
On the other hand, local powerful groups with certain political affiliations can also influence on IPO operationalization in a host-country. In this instance, choosing a capable local partner with strong political and institutional relationship in a host-country can save a lot of trouble. For instance, Respondent 1 argued that In Bangladesh often in the execution stage, Wärtsilä hears complaints from its customers that some local powerful group of people under a certain political influence attempt to impose barriers in project execution. Those local powerful groups often ask for delivering some construction materials, labours, logistics services, etc. to gain some business opportunities or sale locally available raw materials to the project customer company. Even though this issue never influences Wärtsilä’s ability to execute a successful project, but Wärtsilä’s strategy is to let the client company tackle this issue itself. Wärtsilä as a foreign company in the host-society never involve itself in such matters. But, it’s evident that in most of the cases the client companies in the host-society are effectively capable of managing those minor risks (which loosely can be defined as terrorism risks) because of their personal connection and relationship with the local political and powerful public groups. In this instance, Respondent 1 reported,
…“Time to time we hear from our customers that some local people mainly who are under certain political party’s wing come and ask for project works such as delivering logistic services, construction materials, labour, etc. So, if some local people are asking for project works or attempt to impose barriers for smooth operationalization of our project implementation, out Client Company takes care of that. But, I must say that our clients are very capable to avoid and manage such issues arising from powerful local groups.”
Import/Export restrictions
Import/export restrictions as a political risk has been only found relevant to the Chinese case context. One of the main reasons for such restriction is that the power and energy generation industry is under the Chinese government’s top priority industries. In this instance, Respondent 2 submitted,
…“China is a difficult country, it's very difficult for any foreign company to enter into Chinese electricity and energy business market, I would say precisely. And, especially companies from European countries, they don't allow unless you're in a very higher business context.”
Moreover, in China business culture, observance of the contractual law, arbitration procedures, and other institutional aspects always support local Chinese companies over a foreign counter part. And, in most cases Chinese contractual agreements don’t agree with the international intellectual property rights, international contractual rules and regulations such as the European business and contractual laws.
This also imposes critical shade on the export/import ability of a foreign firm considering any future negative outcomes might occur while executing mega IPOs in the Chinese energy market such as imitation of the technology, breach of contract, etc. However, this finding has corroborated with Keillor et al. (2005) where they argued that import restrictions can be imposed upon foreign firms to protect the interests of domestic firms or import substitute producers under industrial grounds.
Thus, keeping an arm length and limited scope contractual agreement with a capable local Chinese company who is willing to do business under European business laws, regulations, and conventions might assist in avoiding such political risk in China. Thereby to support the rationale of keeping Chinese projects to a limited scope in avoiding export/import restriction risk, Respondent 2 argued,
…“We cannot avoid certain restrictions or imitation of our technology in China because they (Chinese companies) don't agree any rules and regulations and the government is supporting their own domestic companies. So, we cannot avoid it but best ways to avoid this is to sell our EPC projects with limited scope.”
Table 18. Identified key political risk elements in IPOs. (Own illustration 2020).
Political risk element
IPO host-country
Bangladesh China India
HQ Global perspective
& Pakistan
Occurrence
Expropriation 0
Breach of contract
3Currency inconvertibility
4Ownership of assets and/or
Personnel restrictions 0
Taxation restrictions
2Import/Export restrictions
1Terrorism
2Demonstrations, riots &
insurrections 0
Revolutions, coups d’état & civil
wars 0
Wars 0
Economic sanctions 0
However, the research has not found any significant empirical evidence regarding expropriation, ownership of assets and/or personnel restrictions, demonstrations, riots &
insurrections, revolutions, coups d’état & civil wars, wars, and economic sanctions as a considerable political risk element in any of the investigated IPOs undertaken by the case company.